This is an assault on living standards set to run and run

Close to the start of the economic crisis, someone I've always considered one
of the City's more astute practitioners privately ventured what seemed a
somewhat startling prediction – by the time it was all over, average living
standards in Britain and many of other advanced economies would have fallen
in real terms by 20pc or more.

The Governor is still as reluctant as ever to concede the central bank's own culpability in the crisis – no mention of that in this week's speech - but it is hard to disagree with the thrust of his comments – that though the policy response may have smoothed the adjustment, it can't eradicate it, and it may now have reached the limits of its capacity to do even that.Photo: PA

At the time, I was minded to dismiss the suggestion as unduly alarmist. As the years pass, however, the forecast is if anything beginning to look on the over optimistic side. Indeed, according to a first attempt by the Office for National Statistics this week to measure "national well being", we are already well on the way, with net national income per head falling by 13.2pc in real terms since the start of the crisis in 2008.

Today's third-quarter GDP figures are widely expected to show the UK economy emerging from its double-dip recession – indeed the Prime Minister virtually confirmed it in PMQ's yesterday. Unfortunately, this totemic piece of good news doesn't really reflect the underlying reality, or the degree to which paying for the excesses of the past through tax increases, spending cuts, unemployment and erosion in real wages is eating into living standards. These are suffering much more severely than the raw output data suggest.

The Governor is still as reluctant as ever to concede the central bank's own culpability in the crisis – no mention of that in this week's speech - but it is hard to disagree with the thrust of his comments – that though the policy response may have smoothed the adjustment, it can't eradicate it, and it may now have reached the limits of its capacity to do even that.

As regular readers will know, I've been progressively more sceptical over the efficacy or appropriateness of further demand management measures to ease the crisis, so I was heartened to hear Sir Mervyn rule out some of the more exotic suggestions for getting the economy going again.

It is perhaps just as well for Lord Turner, one of the pretenders to be Governor when Sir Mervyn retires next year, that the incumbent doesn't have any say on his successor, for Sir Mervyn came as close as he dared to saying "over my dead body".

As it happens, Lord Turner made no mention in a since much interpreted, possibly overly so, Mansion House speech a few weeks back of the term "helicopter money", still less the even more abhorrent alternative of direct financing of the budget deficit by the Bank of England. But if the BBC's apparently well briefed reporting of the speech is correct, then this must be what Lord Turner meant when he said: "And we need to be ready...to consider further policy innovations, and further integration of different aspects of policy – to overcome the powerful economic headwinds created by deleveraging across the developed world economies".

Bank of England insiders speak of almost visceral opposition from Sir Mervyn to Lord Turner as his successor, so the suggestion of helicopter money gave the incumbent all the ammunition he needed to stick the knife in.

In his own speech, Sir Meryn makes a clear distinction between what he calls "good" money printing of the type the Bank of England is already practising through quantitative easing, and "bad" money printing of the "helicopter" variety.

Helicopter money is the term invented by Milton Friedman to describe what a central bank might do in the event of extreme deflationary conditions of the type that existed during the Great Depression, where the money supply is in a state of collapse.

Rather than use the newly created money to buy government debt, which is what has been happening with quantitative easing, the Bank of England might simply distribute it to the population at large, the so-called helicopter drop.

Alternatively, it might gift the money to the government, which could then hand it on in the form of tax cuts and or spending increases, thereby monetising the deficit. If the Bank had used the £375bn so far spent buying gilts in such a way, it would be worth around £6,000 per head of population, a huge fiscal stimulus.

And therein lies the objection to it. A helicopter drop is the point at which money printing ceases to be the legitimate use of monetary policy to meet an inflation target, and becomes essentially an act of fiscal madness, which only the Government itself can undertake. The effect on the pound, government credibility and ultimately interest rates and inflation, would be similar to an unfunded tax cut or spending increase. That way lies Weimar, or Zimbabwe.

There are circumstances in which the Government might indeed wish to use the central bank in this way, as in the context for which Friedman first suggested it – the Great Depression.

But we are actually a very long way from those conditions right now, with the labour market on a strongly improving trend and the money supply, on the Bank of England's preferred measure of broad money, growing at a perfectly respectable 4.2pc.

Sir Mervyn also rightly rejected the notion that the Bank of England simply cancel the gilts it has bought, thereby reducing the national debt. Leaving aside the technical difficulties of doing this – it would be illegal under European law, and it would make the Bank of England insolvent, with all the liabilities but none of the matching assets – it would also be tantamount to an act of default by the UK Government and would thereby overnight transform the country into another Greece, Argentina and other serial defaulters.

The current policy of QE is not the same thing at all, since it merely replaces one asset – gilts – with another – cash - and can therefore be quickly reversed when the economy picks up.

None of this is to suggest that the authorities are getting their policy response broadly right. There is obviously something in Sir Mervyn's assertion that the economy cannot truly mend itself until the banks have fully dealt with their bad debts. But it is a strange old world which sees policy makers such as Sir Mervyn insisting that banks raise more capital to pay for these write-offs in conditions where neither markets nor governments are prepared to provide it. This makes further deleveraging more or less inevitable, requiring repeated rounds of central bank money printing to counter it. It's hard to see how central bankers are ever going to get off this treadmill. As ever in this crisis, the application of policy seems quite at odds with its goals. Thus it is that a crisis caused by too much debt is addressed by yet more debt, even though the end objective is presumably to get this debt off our backs.

The policy response has become a terrible muddle, which in its attempt constantly to put off until tomorrow what properly belongs to today brings to mind the concluding line of the Great Gatsby: "So we beat on, boats against the current, borne back ceaselessly into the past". My City friend was right, this adjustment is on a very long fuse. Enjoy Thursday's GDP figures while you can Mr Cameron. But don't count on them winning you the next election.